First Circuit Holds that Parents’ Tuition Payments for Adult Children Are Fraudulent Transfers

Recently, the First Circuit held that a parent’s tuition payments on behalf of an adult child do not benefit the parent’s bankruptcy estate, and a Chapter 7 trustee may therefore claw the payments back as fraudulent transfers.

The concept underlying fraudulent transfer law is that, if a person cannot pay his debts in due course, it is fraudulent to transfer his assets to another person with a motive to avoid paying his debts. This concept is extended to “constructive fraud” where the insolvent party transfers his assets — without a bad motive — but nonetheless fails to receive reasonably equivalent value in return for the transfer.

In Degiacomo v. Sacred Heart University, Inc. (In re Steven and Lori Palladino), the debtors paid more than $64,000 to Sacred Heart University for their daughter’s tuition. In 2014, the debtors were convicted of fraud for orchestrating a multimillion-dollar Ponzi scheme. The debtors and their business filed for relief under Chapter 7 of the Bankruptcy Code. The Chapter 7 trustee filed an adversary complaint the following year, alleging the tuition payments to Sacred Heart were fraudulent transfers, and seeking clawback of the tuition payments. The parties moved for summary judgment, and the bankruptcy court ruled in favor of Sacred Heart. The bankruptcy court ruled that the debtors believed they would benefit from having a self-sufficient daughter, and such benefit was reasonably equivalent value for the tuition payments.

On direct appeal, the First Circuit reversed the bankruptcy court’s ruling. The First Circuit noted that, although there is currently a divide among courts as to whether tuition payments made on behalf of an adult child may be clawed back as fraudulent transfers, the recent trend has favored trustees. The First Circuit considered whether the debtors received value — particularly in a form that is recognized under the Bankruptcy Code — as a result of paying their adult daughter’s tuition. Finding that the debtors did not receive any value for the tuition payments, and in fact did not have any legal responsibility to pay for their adult daughter’s tuition, the First Circuit held that the tuition payments were fraudulent transfers. Mere intangible, emotional, and non-economic benefits are not the type of value that can withstand a fraudulent transfer claim.

What’s Next?

As student loan debt increases, we can expect to see more cases where parents have made payments on their adult children’s loans or tuition. Should those parents file for bankruptcy, the First Circuit’s recent decision may support claims to recover student loan payments as fraudulent transfers. The courts remain divided on these issues, but we can anticipate more litigation in the future.

Notably, the First Circuit acknowledged that, if the debtors’ daughter had been a minor, the outcome could have been different. Because debtors have legal responsibilities to provide for their minor children, under certain circumstances, school tuition payments may not be considered as fraudulent transfers. However, courts are divided on this issue as well.